Predictions of the end for annuities may be premature.
Anyone reading the press over recent weeks may have assumed that most annuities will soon go the way of the dodo. Many were quick to signal their demise after George Osborne announced a more favourable tax treatment for inherited pension funds.
The Chancellor’s surprise announcement seems to have been rushed out ahead of the Autumn Statement in an attempt to boost the Conservative Party Conference. Despite the peculiar timing, the proposal was well-received, as thousands of families who inherit unused pension pots, or funds already in drawdown, look set to benefit from reduced tax bills from April. Most people who buy an annuity with their pension fund will not enjoy such advantages as the capital is usually lost after death.
On the face of it, the announcement that pensions designated to drawdown will no longer be subject to any tax, if death occurs before age 75, is to be welcomed. The same generous tax treatment will apply to funds left untouched within the pension fund, regardless of age at death. Along with the raft of pensions freedoms announced earlier in the year, it’s a move that could make pension saving even more attractive.
By abolishing the so-called ‘death tax’ the government seems to be incentivising drawdown over annuities as an Inheritance Tax-efficient vehicle for providing income in retirement. Many have predicted that, as a result, sales of most types of annuity will plummet. But to suggest annuities face extinction may underestimate their value, because in many cases they remain an appropriate option. Annuities could still play a role in providing a guaranteed income and offer a great deal of security for many people in retirement. After all, it is guaranteed income for life, rather than the tax treatment when passing the fund on, that is often the primary concern for retirees.
It’s also worth considering that most of the Chancellor’s generosity extends to beneficiaries of those who die in drawdown before age 75. After 75, tax will be charged at 45% if the drawdown fund is taken by the beneficiary as a lump sum, or at their marginal rate if they choose to receive the income. Most people reaching retirement age will comfortably surpass 75 years: in 2011–2013 a man in the UK aged 65 had an average of 18.3 years of life remaining and a woman 20.8 years1. It is likely, therefore, that the majority of beneficiaries will pay tax, albeit at a reduced rate compared to the current level of 55%.
With drawdown certain to appeal to more people from the point of view of IHT planning, without the right advice individuals could end up exposing themselves to risks they cannot afford to take. In a worst-case scenario, after a period of severe market volatility and/or excessive income withdrawals, a modest drawdown fund could be depleted, leaving the retiree with no income and the family with nothing left to inherit. With an annuity, there’s no option to inherit, but you never run the risk of running out of money. It’s why they have stood the test of time for so long.
And it’s not always a case of choosing one solution over the other. A combination of drawdown and annuity can provide the best of both worlds for people looking for income flexibility and security in retirement.
Much of the detail is yet to be firmed up, but the changes are expected to be introduced from April 2015. It’s clear that annuities will continue to play a part in retirement planning – to what extent remains to be seen. But one thing is certain: taking advice to help examine your options is more vital than ever.
1 Source: www.ons.gov.uk National Life Tables, United Kingdom, 2011-2013
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.